Rick Kalvoda 0:00
There’s a lot of questions is what is VAT? Where is value at this point, and you have what, you know, anytime there’s uncertainty and there’s a freeze up, there’s no transactions occurring, you have what we call it a bid ask spread. What someone’s willing to sell at their asking price is different, what someone is willing to buy it at the bid price. And so that spread means market value is not the asking price. It’s not the bid price, but it’s somewhere in between. And so that is a, especially when you get to office that is a widespread, everyone has the exact answer, they know exactly where the price is, it’s just no one agrees as to where that is, you know, if you’re an owner, you’re at the upper end of that range, if you’re a buyer wanting to buy you’re at the lower end of that range. And so from a value perspective is their their challenge. And it’s always a challenge in markets, when there’s no transactions, you know, it’s like going, you know, logging into your stock account and you want to sell a stock and there’s no buyers, well, what’s the value of that you really don’t know and or vice versa, if you want to, if you want to buy and there’s no sellers, is it’s figuring out where that is. And and it’s really using anecdotal information, it’s talking it’s a lot of communication, talking with brokers and investors and, and lenders and trying to get a feel and understanding all of that data and bringing that together and formulating an opinion of value. So a lot of discussions a lot of different opinions right now, probably the best way someone you know, or when a client you know, explain this is, you know, is where you know, you may not know where the value is, but you know where the value is not.
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J Darrin Gross 2:03
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Today, my guest is Rick Kalvoda. Rick is the President of the Analytics Branch for the Americas of Altus Group, which is a service provider of intelligence to the global commercial real estate industry. Rick has over 30 years of experience in commercial real estate consulting with a focus on valuation and management. And just a minute we’re going to speak with Rick about Data Insights into the Quickly Changing State of the Commercial Real Estate Market. But first, a quick reminder, if you like our show, CRE PN Radio, there are a couple of things you can do to help us out. You can like share and subscribe. And as always, we encourage you to leave a comment. We’d love to hear from our listeners. Also, if you want to see how handsome Our guests are, be sure to check out our YouTube channel. You can find us on YouTube at commercial real estate pro network. And while you’re there, please subscribe. With that I want to welcome my guest, Rick Kalvoda. Welcome to CRE PN Radio.
Rick Kalvoda 3:54
Thanks, Darrin, good to be here.
J Darrin Gross 3:57
Rick, I’m looking forward to our conversation. Before we get started, if you could take just a minute and share with the listeners a little bit about your background.
Rick Kalvoda 4:04
Sure, as you mentioned a little over 30 years in the commercial real estate business started out on the valuation side doing doing valuations. And we probably about 10 years into my career. We were acquired by PricewaterhouseCoopers. So that’s where I started more the advisory side of the bet so valuation advisory side of the business. And for the past 13 years I’ve been with Altus Group, as you said, leading global provider of not only advisory services, but then also data and software as well in the commercial real estate industry. So that’s been my 32 year career business.
J Darrin Gross 4:47
Got it. So as a an asset valuation specialist Are you agnostic to the class of asset or do you have a focus?
Rick Kalvoda 4:59
I’m primarily whatever, whatever our investors and so we work with some of the largest institutional investors across the globe. And so they will historically have primarily focused on the four major food groups. So think office industrial, multifamily, and retail. That has changed quite a bit over the past, let’s call it 10 15 years where there’s been other alternative asset classes that have come into or sectors that they’ve invested into. So think student housing and and single family rentals and self storage, medical office sucks address. So we pretty much work with any of those real estate sectors.
J Darrin Gross 5:46
Got it. So as far as the the valuations go, you mentioned last 15 years. We’re recording this in March of 2023. There’s been a little bit of turmoil in the marketplace in the last year with interest rates and not to mention COVID and etc without supply chain stuff. What are you seeing as the the most affected positively and negatively asset class for valuations.
Rick Kalvoda 6:25
So if you if you look at you mentioned COVID, and then now you know, with interest rates, if you think back to COVID, over the past three years, think not only multifamily, but then also industrial and more specifically industrial has been very positive, positively impacted as we went more to online shopping as opposed to you know, in in, in store shopping, is industrial has had just a phenomenal and then also think of the amount of money that has been put into the system think fiscal stimulus, think lower interest rates, quote, unquote, free money, much more spending that has occurred. And so warehouses by far been industrial warehouse has by far been the biggest beneficiary in terms of sectors over the past three years from COVID. Looking to today, now as part of the inflation and now the Fed now fighting inflation with the increasing interest rates and backing off and that liquidity, really all asset classes have been impacted. All sectors of in commercial real estate have been impacted. But from a fundamental perspective, most of the impact has flown or has gone to office and think of the work from home phenomenon. And and, yes, there’s been more of a back to Office focus in the US that’s been less successful. I think everybody will argue as to eventually where you know, how much of that work, work from home will stay and how much back to the office, there will be. But I think everyone will agree is it’s not going to be the same as what it was, you know, pre COVID. And so from a fundamental perspective, if you need less office than you needed, before the start of COVID, that’s going to have an impact. And especially now, as you have more stress in the market, more increasing interest rates, people are more focused on expenses, companies are more focused on expenses, they really look more closely at the need for the office space that they have, and really look at their return off as Paul policies on a go forward basis from a fundamental perspective, both from COVID but also now just the stress in the industry and in the economy is office has been most impacted.
J Darrin Gross 8:50
And no doubt. I’m curious, the clients that you you work with, you know, the commercial industry. The commercial real estate industry is kind of far and wide. Is it primarily the investor side or is it is it lender side? Or is it all all of the participants in the in the real estate market?
Rick Kalvoda 9:16
I a little bit of all but from the valuation, perspective valuation, especially the valuation you met mentioned the Bayerischer management focus that we have. That’s more on the investment manager side. So on behalf of the institutional investors, institutional investors will generally invest in a open ended fund or in a closed end fund, they’ll commingle that money into a fund where the manager of that fund the investment manager will go out and invest and buy and sell and operate the real estate. So we’ll work with those investment managers on the fund will work on helping them with that mark to market on a quarterly basis sometimes monthly sometimes even Daily, there’s no products out there now or even on a daily basis, they’ll need a mark to that to the underlying real estate. And so generally it’s we do work with investors, we do work with lenders, but primarily, it’s the investment managers of that commercial real estate.
J Darrin Gross 10:18
And within that mark to market requirements for the funds, have you seen a lot of, of willingness or letting go of some of the assets that are performing? Or is it more a matter of just recognizing that the the asset values have have lessened in the office type of acid?
Rick Kalvoda 10:41
Yeah, Dan, really, just because of debt is a very important part of commercial real estate. And so as that cost of the debt as interest rates have increased, is that’s going to impact the overall value of the commercial real estate of the assets. Generally, the institutional investors use less leverage, so they’re less directly impacted by it, but debt will impact just real estate asset prices overall. And so that that has an impact whether you’re buying for cash or buying, you know, we’re buying with leverage. So that that has an impact. As far as recognizing, you know, that is the big discussion right now, in terms of, you know, adjustments, you know, to those marks. There’s been a lot of that, let’s call it uncertainty, given that there’s no transactions because of the uncertainty. Where’s How far is the Fed gonna hike? Where’s inflation going to be? You know, three months, six months, a year? Where’s the fundamentals from office for office, not just now, but a year, three years from now, the lot of questions right now, just in the macro economic part of the market, but then also the commercial real estate market as well. is there’s a lot of questions is what is that where is value at this point, and you have what, you know, anytime there’s uncertainty and there’s a freeze up, there’s no transactions occurring, you have what we call it a bid ask spread, what someone’s willing to sell at their asking price is different, what someone is willing to buy it at the bid price. And so that spread means market value is not the asking price. It’s not the bid price, but it’s somewhere in between. And so that is a especially when you get to office that is a widespread, everyone has the exact answer, they know exactly where the price is, it’s just no one agrees as to where that is, you know, if you’re an owner, you’re at the upper end of that range. If you’re a buyer wanting to buy, you’re at the lower end of that range. And so from a valuer perspective is their their challenge. And it’s always a challenge in markets, when there’s no transactions, you know, it’s like going, you know, logging into your stock account, and you want to sell a stock, and there’s no buyers, well, what’s the value of that you really don’t know, and or vice versa, if you want to, if you want to buy and there’s no salaries, is it’s figuring out where that is. And, and it’s really using anecdotal information, it’s talking, it’s a lot of communication, talking with brokers, and investors and, and lenders and trying to get a feel and understanding all of that data, and bringing that together in formulating an opinion of value. So a lot of discussions, a lot of different opinions right now, probably the best way, someone, you know, or when a client, you know, explain this is, you know, is where, you know, you may not know where the value is, but you know where the value is not. And it’s not where it was yesterday, it’s not where you know, where the bid is where the ask is, it’s, it’s somewhere in between. And so you triangulate using all that data, and probably right now just talking about, specifically with Office data’s as you see some of the borrowers start, you know, had the properties back to the lender, is you now are stressing, well, now it helps establish where that value is doesn’t necessarily mean at that price at that, you know, where are they because sometimes it’s just used for negotiations and negotiating with the lender. But that’s what you might consider more of a distressed transaction, distressed sale, that doesn’t mean its market value, until you start seeing a lot more of that stress, which then becomes the market. And those are things that the third the appraiser needs to consider when they’re determining what that value is.
J Darrin Gross 14:28
Ya know, the, the, you know, just kind of the scenario you were talking about, there were some of the the investors are given, you know, properties back to the bank. You know, that’s kind of that that I don’t see a slippery slope, but it’s it, at least in the asset class of office. It seems like it could there could be a domino effect, but I’m assuming or they’re not. So I’m on the The bid side of the thing of the bid ask where there’s some, some opportunist investors waiting for something like that to happen to, you know, acquire properties like that.
Rick Kalvoda 15:14
Yeah, absolutely is is, you know if there’s a positive thing in the market right now is that there is a lot of capital out there that still wants to invest in commercial real estate, you know, there are people on the sideline looking and same thing happened after the GFC. Same thing happened, you know, back in the.com, is you had a lot of investors looking to take advantage of any drop in price to get in for the longer term, because commercial real estate is more of a long term investment. And so there is capital, they’re waiting, but given the uncertainty, given the risk, that they’re ascribing to the unknowns going forward, whether it’s on fundamentals, whether it’s on debt, whether it’s on pricing, whether it’s on the economy, is there waiting for a point, you know, you could say the same thing with stock market waiting for a point where it reaches a certain level before they will actually take the opportunity, opportunity to invest at that point. And so this positive, there’s capital there, the negative from a perspective of looking at this value perspective is, it’s not where the ask is now, it’s definitely something, you know, lower that. And another way we look at it is if you look at times where there’s no transactions, and there’s a bid ask spread, early in that cycle, is or in that time period, early is the market value is probably closer to the asset than it is to bed. But every day that goes by that things don’t change, and there’s still that bit s spread, the value that market values likely declining, you’re going closer and closer to where the debate is. So where we are right now, we’re probably, you know, nine months into, you know, where things started, you know, the Fed started raising, you know, second quarter of last year, we’re seeing where it’s, you know, we’re starting to see those, you know, declines, you know, accelerate, or, you know, seeing more and more of those adjustments to market value.
J Darrin Gross 17:11
Is there any data that you guys focus in on with respect to? How close one is to their, their rate term expiring? Or how, you know, how old their their dead is? On Does that, does that tend to be a, a, an action point, where where you see, you know, more, I don’t say desperate, but more activity occurs based on your, you’re nearing a point where you’ve got maybe an empty building, and you’ve got financing that’s expiring, and you’re gonna have to refinance, and you’ve got, you know, the situation becomes more dire, does that create any more of a need to act? Or is it? Was it none?
Rick Kalvoda 18:00
Yeah, no, that’s, that’s what we would call a compelling event is, or a critical event where, when you mentioned, it’s not just office, it’s really, you know, if you think about increasing interest rates, not only is that debt, so you may have a lower interest rate on that debt. And when it comes up for refinancing is now it’s at a higher lift. So not only will you be paying more for the debt service on that new loan, but then also, the value of that property like that underlying collateral know that asset is likely declined, that fundamentals are the NOI of that property to service, that debt has likely declined. And then on the flip side is, is there’s more uncertainty and your net, seeing the, you know, especially in, in office, we hear all the time, it’s inevitable, no, no lender wants to land on off, it’s just given the uncertainty of the values of the, you know, the debt sector, specifically. So you have all those factors that come together. So yeah, we do track information on properties across the US that where loans are coming due. That is a big focus this year with the amount of commercial real estate loans that, that that are maturing this year, and to your earlier suggestion is what happens, you know, as you know, if more of those properties are handed back to the lenders, or even just negotiate with lenders, what happens when that accelerates and if fundamentals don’t improve, if the economy does improve, if interest rates continue to go up further and values continue to climb further, all of that, you know, is is some of that risk and uncertainty that investors are looking at now and therefore, you know, from from a buyer’s perspective, demanding, you know, or they’re providing a lower bid before they actually, you know, invest in the market.
J Darrin Gross 19:59
So if we just exited a low interest rate environment, and most of the properties in the marketplace have lower debt on them, do you expect kind of a wave as this is the the older term start to expire that this will then increase and then that that will kind of like create that, that the valuation or mean will that kind of like, set the floor for, for, you know, the market and at that point, then the deals will, will start to happen, because the price has been set as a kind of the, the 123 of it or,
Rick Kalvoda 20:39
um, yeah, I mean, if you do see if it accelerates, and you see if the distress, whether it’s and and the keys back to the lender, the lender, then you know, they have real estate owned and reo. And then they, you know, they’re not, you know, in it for ownership, and so they’re looking to get it off the books, and so they then turn around and sell it, you know, in those distressed scenarios, if that becomes more the standard, if that becomes more reflects what’s happening in the market, because it’s happening that frequent, then that’s indicative of where market values, you know, shouldn’t be, you know, at that point, and one thing I’ll say with and specifically when we’re looking at office, and and you could correlate this to retail, especially regional malls 1015 years ago, is it really gets down to not just, you know, this sector, not just the market, not the, you know, the sector within that market. But really down to the individual property down to the individual assets, we used to say 10 years ago is what the regional malls Do you have the haves and the have nots, you had those that, you know, if you think of, you know, of a city or metropolitan area, and if you had five malls, it’s likely to go down to two miles or three miles. And so the haves those that will actually might benefit from closing of a couple of malls, and then those that just won’t make it, you know, in a bike malls and a three mile town, we’re starting to see the same thing with Office is as there’s less need for office space, think work from home, thank you know, if the economy slows or goes into a recession, there’s less need for that offices, which buildings will do very well, the top of the market, which ones will do, okay, in which ones it’ll be at the expense of the other, you know, the third, the third component there. And so you really have to look at those individual properties, what are the amenities? What are, you know, ESG is a big focus. Now, tenants won’t look at certain buildings, unless they’re, you know, certainly, you know, certification. And, and so it becomes much more focused, again, not just on the market, but now that particular you know, that particular asset, especially when it comes to, to Office, and so, so it isn’t just a hey, everything’s down, you know, X percent, did, you know, what is this building relative to other buildings in that in that market? Makes it much easier?
J Darrin Gross 23:10
So the average, what’s an average term? As far as debt financing for office? Is it seven to 10 years as far as rate law? More like five? by five? Yep. Okay. So theoretically, if, if we’re in year one have higher interest rates, within five years, this will, this will reset, is that
Rick Kalvoda 23:37
I? Well, you could say you’re seeing the reset now, because as those low interest loans, that that low interest debt over the past five years, you know, have been in the term can be longer than as well, but let’s call it five to seven years, is past five to seven years, as that’s now coming due. That’s when the reset occurs is when you adjust to that new level, because can can that property support that new level of debt service? And at the same time, I mentioned all the amenities needed in office, you know, that requires investment into, you know, into the building. So is there equity, and is there capital there from the owner? Is there willingness, you know, from the owner to invest that extra capital into the building, in order to support long term the debt service on that new loan. So, that’s really starting to happen right now. Then you started seeing, you know, some things, you know, from, from the lending perspective on offices, properties going back are being negotiated with the lender is happening over the past. Let’s call it the past three months, is that’s what you know, we’re watching very closely over the next, you know, six to 12 months, next two years as to what happens in terms of as those loans loans come due, then for the next five years as those are renegotiated or extended or have new loans at that higher level that actually helps helps the market longer term because now if it has no lending or it has a bone or if it was handed back and it was recapitalized with the with a lower level of loan against the property, then now that that helps that asset, it’s repriced, that helps the asset and the market on a go forward basis as well.
J Darrin Gross 25:24
Right, definitely the go forward, once you get through that stall, and the, the, the bid ask, and, and all the lending there. So if you were going to advise the listeners on what to do, or how to prepare for the next, or who as we go through this transition, what would your advice be? For you know, how to prepare and what to do to, to get through this?
Rick Kalvoda 25:52
Yeah, I would, I’d say, that mentioned, you know, earlier is just, you know, communication is very important. So it’s, you know, being, you know, with the lender, with the broker, with participants in the marketplace, is, as everyone’s trying to figure this out, is very important. And the second thing is, is and it’s gotten better, you know, over the past, you know, 2030 years, but is, is what the data is having the data and, and and you mentioned at the earlier, just data insights, you know, when an author says hope focuses on intelligence as a service, and so providing not only that, you know, the advice the, as a trusted adviser, not only having the software, you know, the technology behind it, but having that data and bringing that data together to make those informed decisions, whether it’s on an acquisition, whether it’s on a disposition, or whether it’s on an ongoing ownership, which you know, back to especially, you know, you think offices, which ones are the haves, which ones are the have nots based on the just voluminous amount of data that’s out there in the market, bringing that together to make an informed decision on on, on, on, you know, what your strategy is acquisition disposition, or, you know, ownership or, or, you know, improving in reinvesting in the property is, data is just so critical. You know, right now, anytime, it’s funny, just some of the data that and advisory services that we provide to our clients over the past 10 years, that wasn’t being used that much, because you just saw just a very consistent 1%, you know, every quarter was just you saw the tick up right up to COVID. And it was there wasn’t that need for that amount of data and the analytics behind that data. Now, as you see volatility, but probably more importantly, the uncertainty in the market. Now, it’s even more critical to have that, you know, information right now. So those are probably the two things, you know, it’s it’s communication, talking with people in the industry, but then also having the data, you know, to make informed decisions, those are probably the two biggest things.
J Darrin Gross 28:01
Hey Rick, if we could, I’d like to shift gears here for a second. By day, I’m an insurance broker. And as such, I work with my clients to assess risk and determine what to do with risk. And there’s three strategies we typically consider, we first look to see if there’s a way we can avoid the risk. And then if that’s not an option, then we look to see if there’s a way we can minimize the risk. And when we cannot avoid or minimize the risk, we look to see if there’s a way we can transfer the risk. And that’s what an insurance policy is. And as such, I like to ask my guests if they can look at their own situation, could be your clients, investors, tendons, the market interest rates, political however, however, you’d like to identify what you consider to be the biggest risk? And again, for clarification, while I’m I am an insurance broker, I’m not necessarily looking for an insurance related answer. And so if you’re willing, I’d like to ask you, Rick Kalvoda, what is the Biggest Risk?
Rick Kalvoda 29:04
Yeah, I think. So operating expenses of which, you know, insurance is is a big component, you know, the risk, I think, right now have ownership of commercial real estate. I think right now, and this kind of goes back to the uncertainty and what’s going to happen with inflation, what’s going to happen with interest rates, what’s the Fed going to do is just, it’s the uncertainty. And as the Fed continues with that increases, the biggest risk right now is is there, you know, is there a global financial crisis, you know, you starting to see the stress on some of the banks, you’re starting to see, as I mentioned, with some of the, you know, blending or the borrower’s, you know, handing keys back to the lenders, you’re starting to see some of that, at the same time, slowing economic growth, you know, and also increase inflation, all that stress to the economy that if we go into a recession if we continue to have higher interest rates and that that’s going to have an impact not just on commercial real estate, but across all asset classes, but then specifically, commercial real estate and especially with, you know, the amount of lending done by the regional banks, which you know, are, over the past couple of weeks have seen this stress is, that’s probably the biggest, you know, concern out there is in biggest risk for our investor and for our clients, is just what happens, you know, the overall macroeconomic picture and there’s just so many different things impact again, on top of that, you know, back to your comment just on insurance is just with the, you know, you just think of the climate risk and everything that’s, you know, happened this year, and, and how that impacts, you know, commercial real estate, whether it’s rising, you know, ocean levels, etc, is, all of that has, you know, so our clients, the owners and operators of that commercial real estate, not only have to think about that, but then the macroeconomic you know, side of it as well. So, so a lot of risks now, hence the uncertainty, but that’s, we’re all here to help the industry out, you know, in times of risks like that, ya
J Darrin Gross 31:12
know, plenty of risk to go around, that’s for sure. Hey, Rick, where can listeners go if they’d like to learn more connect with you?
Rick Kalvoda 31:21
i You can go to our website, altusgroup.com and reach out and we’re happy to help. You know, with any, any data software services needs they have in the commercial real estate business.
J Darrin Gross 31:36
Awesome. Well, Rick Kalvoda, I cannot say thanks enough for taking the time to talk today. I’ve enjoyed it. I learned a lot, and I look forward to doing it again soon.
Rick Kalvoda 31:48
Absolutely. Anytime. Thanks, Darrin.
J Darrin Gross 31:50
All right. For our listeners. If you liked this episode, don’t forget to like, share and subscribe. Remember, the more you know, the more you grow? That’s all we’ve got this week. Until next time, thanks for listening to commercial real estate pro networks. CRE PN Radio.
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